8/25/2008 @ 12:03PM

Google's Online Video Quandary

Last summer there was a bit of a kerfuffle when one analyst’s misdirected math led to wildly swinging estimates for a new advertising model for YouTube, the online video-sharing site owned by
Google
.

Morgan Stanley analyst Mary Meeker’s original forecast suggested the model–small overlay ads that run on the bottom of online videos–would contribute $720 million in net revenue. Silicon Alley Insider analyst Henry Blodget kindly pointed out that Meeker had made a small error, meaning the actual estimate was a mere $720,000. Meeker dug back into the calculations and provided ranges from $76 million to $189 million. Blodget’s own analysis suggested year-five revenues ranging from $200 million to $13 billion.

One year later, the only thing that’s clear is that YouTube’s financial performance is not meeting the expectations that led Google
to pay $1.7 billion for YouTube in 2006. The problem isn’t traffic, with YouTube now reaching close to 60 million consumers a month. Rather, YouTube hasn’t found a way to have revenue grow at the same pace as traffic.

Why have YouTube’s revenues grown more slowly than projected? One key challenge is that Google’s core business model–matching search terms to ads–hasn’t naturally fit with YouTube’s model.

When Google purchased YouTube, some analysts expected it could port that model to video, turning YouTube’s traffic into a gold mine. Unfortunately, it’s not that simple. The keywords that describe a video don’t always provide sufficient information to guarantee a successful match with an advertiser’s target customer or message.

For example, imagine that a pet food company wanted an ad tied to the search term “dog food.” While that search highlights vintage dog-food commercials, it also brings up a video spoofing disgraced NFL player Michael Vick, who is in jail for charges related to dog fighting, and a video titled “Alert! Rat poison in pet food boycott China K9 Killers!” Pet food companies are not likely to be excited to be paired to these kinds of videos.

All in all, Google sells ads against only about the 3% of YouTube’s videos that are provided by or cleared by media companies. The other 97% is off limits.

Also, Google faces a classic quandary. The most “proven” money-making model for video advertising is to run short ads before or after a video plays (in industry lingo a “pre-roll” or “post-roll”). Extensive pre-rolls might cause angst among YouTube users who appreciate the ability to flip from video to video.

So YouTube is left with a huge audience but an uncertain business model. In some ways, this challenge should feel familiar to Google–it debuted in the late 1990s as one of close to 20 different search engines. While superior technology helped Google succeed, what really allowed it to break free from the pack was its disruptive business model that allowed companies to bid to place text-based ads tied to specific search terms.

While Overture (acquired by
Yahoo!
in 2003) pioneered the model of auctioning off search terms, Google put together an end-to-end model that made it simple and effective for companies of any size to advertise online, creating a juggernaut.

Google doesn’t appear to be innovating to the same degree in the online video space. Rather, it appears to be trying to force-fit models that work on traditional television or on the Internet onto video advertising. This approach–cramming old models into new spaces–rarely produces breakthrough results.

Google needs an innovative business model to realize the potential of online video. Meanwhile, contenders are emerging online. One, start-up company VideoEgg, has introduced a series of online advertising models meant to deepen user engagement.

One such model places “widgets” at the bottom of an ad that allow users to see different versions of the ad or get more information. VideoEgg only charges advertisers if a consumer actually engages with an ad in some way.

VideoEgg’s model might not be the answer, but overlays and pre-rolls are not likely the answer either. If Google tries to force-fit old models onto online video, it will create space for a competitor to do to it what it did to Yahoo! and Overture.

Excerpted from a recent issue of the newsletter, Strategy & Innovation. Written by Scott D. Anthony, president of Innosight.